Making sense of stockmarket bubbles
Vivek Kaul Friday, February 10, 2006 21:11 IST
Never follow the crowd —Bernard Baruch
…the fact is it is really quite comfy to be a part of the crowd — Adam Smith
MUMBAI: Kavi Kumar had just finished taking a class on financial markets at the Sentinel Centre for Human Resources Development. During the course of the class he had tried to explain that the price of a stock equals the future expectations the market has from the stock.
Towards the end of the class, one of the students, Ashwini Kumar, had suddenly woken up from a snooze and asked: “All that’s fine. But it’s never too obvious as to what the future is. And doesn’t that lead to stock market bubbles, when a rosy picture of future is painted and then you have excess cash chasing a single investment theme?”.
The question had stayed in Kumar’s mind. Future is so uncertain. And predicting how a company will perform in the days to come is such a difficult task. Chances are that the actual scenario might turn out to be very different from what the expectations are.
A particular sector that is deemed to be hot as of now may not perform in the future. But for the time it is deemed to be hot, a lot of money will flow into the stocks in that sector leading to increased valuations which investors will realise in retrospect were not really justified in the first place. There perception of future might turn out to be wrong.
James Surowiecki , in his book The Wisdom of Crowds, says, “The problem with the stockmarket is that there never is a point at which you can say that it’s over, never a point at which you will definitely be proved right or wrong. ” The stockmarket might eventually get it right, but till it gets it right there is a bubble in place that keeps bloating as more and more investors chase the same set of stocks.
“But what makes investors invest in the same set of stocks?” wondered Kumar. The answer for this is provided by Robert Shiller in his all-time classic Irrational Exuberance.
He says, “A fundamental observation about human society is that people who communicate regularly with one another think similarly. There is at any place and in any time a zeitgeist, a spirit of times”.
If a person wants to invest, the chances are he will look around to see what his acquaintances, neighbours or relatives are doing with their money. The desire to conform to what others are doing is a fundamental human trait. But the prices cannot keep going up forever. Sometime in the future a crash might occur.
(The example is hypothetical)
Never follow the crowd —Bernard Baruch
…the fact is it is really quite comfy to be a part of the crowd — Adam Smith
MUMBAI: Kavi Kumar had just finished taking a class on financial markets at the Sentinel Centre for Human Resources Development. During the course of the class he had tried to explain that the price of a stock equals the future expectations the market has from the stock.
Towards the end of the class, one of the students, Ashwini Kumar, had suddenly woken up from a snooze and asked: “All that’s fine. But it’s never too obvious as to what the future is. And doesn’t that lead to stock market bubbles, when a rosy picture of future is painted and then you have excess cash chasing a single investment theme?”.
The question had stayed in Kumar’s mind. Future is so uncertain. And predicting how a company will perform in the days to come is such a difficult task. Chances are that the actual scenario might turn out to be very different from what the expectations are.
A particular sector that is deemed to be hot as of now may not perform in the future. But for the time it is deemed to be hot, a lot of money will flow into the stocks in that sector leading to increased valuations which investors will realise in retrospect were not really justified in the first place. There perception of future might turn out to be wrong.
James Surowiecki , in his book The Wisdom of Crowds, says, “The problem with the stockmarket is that there never is a point at which you can say that it’s over, never a point at which you will definitely be proved right or wrong. ” The stockmarket might eventually get it right, but till it gets it right there is a bubble in place that keeps bloating as more and more investors chase the same set of stocks.
“But what makes investors invest in the same set of stocks?” wondered Kumar. The answer for this is provided by Robert Shiller in his all-time classic Irrational Exuberance.
He says, “A fundamental observation about human society is that people who communicate regularly with one another think similarly. There is at any place and in any time a zeitgeist, a spirit of times”.
If a person wants to invest, the chances are he will look around to see what his acquaintances, neighbours or relatives are doing with their money. The desire to conform to what others are doing is a fundamental human trait. But the prices cannot keep going up forever. Sometime in the future a crash might occur.
(The example is hypothetical)
posted by Vivek at 12:02 AM
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